CHAPTER TWO

LITERATURE REVIEW
2.1 THEORETICAL BACKGROUND OF THE STUDY
2.1.1 RAW MATERIAL INVENTORY MANAGEMENT
There are many types of inventory that can be held throughout a supply chain. They include raw
material, work in process (WIP), finished goods inventory and spare parts. (Hopp & Spearman,
2000) define raw material as the components, subassemblies, or materials that are purchased
from outside the plant and used in the fabrication / assembly process inside the plant. The idea of
managing the raw material is to have it available when it is needed by the production system.
Since most of the time we cannot receive the raw material immediately (in a just-in-time
fashion), carrying inventory stock of raw material seems appropriate. The size of the stock can
be influenced by several factors; quantity discount received from the supplier, variability in
either the supply or demand, or the materials can become obsolete.

(Goyal, 2015) considered an inventory model that unified the inventory problem of raw material
and finished products for a single product manufacturing system. He pointed out that the
problem of determining the optimal procurement policy for raw material cannot be treated in
isolation, it depends on the production batch size of the products that required the raw material.

Later (Kim & Chandra, 2010) developed a heuristic procedure to classify the raw material into
fewer groups so that it could be used in Goyal’s model. They assumed that the unit
replenishment cost in a group is a decreasing function of the number of raw material in that
group.

(Hong & Hayya, 1992) developed an exact solution procedure for finding the optimal inventory
policy for raw materials and grouping them into fewer groups. They presented a numerical
example and used Kim and Chandra’s procedure to compare their result. Their total cost was
about 20% lower than Kim and Chandra’s model but there were some differences in the
assumptions for the demand rate for the raw material.

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(Sarker & Parija, 1996) developed an ordering policy for raw material for a single manufacturing
batch. The objective was to minimize the total cost while at the same time meeting the demand
of the production facility. Using an integer approximation they were able to reach the optimal
solution.

Having a service level constraint in the inventory models is very important because it measures
the probability that all orders will be delivered with the stock on hand for a specific time interval.
If this constraint is omitted, then we might not have any incentive to carry inventory at all, and
our customers orders will be backordered until we have accumulated a number of them, and at
that point we will place the order. Another possibility is to assign a cost for backorders; that way
the model itself will try to minimize the number of backorders occurring in a period of time.

(Tijms & Groenevelt, 2001) present a useful approximation for the reorder point, s, such that the
required service level is achieved. In their paper, they considered both scenarios where the
review policy can be either periodic or continuous.

Manufacturing
Manufacturing is a global business that was started during the industrial revolution in the late
19th century to cater for the large scale production of products (Jovane et al., 2008). Since then,
the manufacturing business has changed tremendously through the innovations of technology,
processes, materials, communication and transportation. According to (Chryssolouris et al.,
2008) the major challenge of manufacturing is to produce more products with less material, less
energy and less labor involvement.

In order to face these challenges, manufacturing companies must have strategy and competitive
priority in order for them to compete in a dynamic market (Thun, 2008). According to Skinner
(2007), “a manufacturing strategy is a set of manufacturing policies designed to maximize
performance among trade-offs among success criteria to meet the manufacturing task determined
by a corporate strategy”. It is the responsibility of the top management of the company to ensure
that there is a coherent manufacturing strategy and policies derived from internal and external
sources of information to support the whole company’s mission (Paiva et al., 2008).
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High Volume Manufacturing
High volume manufacturing (also known as mass production) involves producing products in
large quantities (Váncza & Egri, 2006). According to (Partanen & Haapasalo, 2004), the term
mass production is used because of the high demand rate of the particular product. Normally, for
high volume manufacturing, only small numbers of different products are manufactured by the
company. This type of manufacturing is associated with long assembly lines where factory
workers or machines continuously turn out the same product month after month.

Quality Production
Quantity production is one category of high volume manufacturing, which concentrates on the
mass production of a single product by using single standard equipment (Cárdenas-Barrón,
2009), for instance, products that come out from stamping press which is a repetitive process
especially for the blank shapes (Kamalapurkar & Date, 2006). The process is a continuous
operation whereby material is fed to the machine either manually or automatically. The machine
will then turn the material into the final product and the same process continues until the desired
quantity is achieved.

Assembly Lines
An assembly line is a manufacturing process which has linked workstations by conveyors or a
similar material handling system so that each product goes from one operation directly to the
next and so on (Özcan & Toklu, 2009). According to (Maqsood et al., 2011), an assembly line
consists of a number of workstations that consistently perform certain operations on a work piece
in a cycle time (maximum or average time available for each work cycle). As a result, each
product follows the same routing of operations and identical final product is expected at the end
of the line (Kara et al., 2009).

The complexity in the process of producing a product is mainly depending on the number of its
components and the assembly levels. The product’s structure is defined as the Bill of Materials
(BOM) (Chan et al., 2009). This category of production is best referred to as an assembly line of
products such as cars. When every product is identical at the end of the assembly line, the line is

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classified as a single model production line. Fundamentally, assembly lines were developed for a
cost efficient high quantity production of a single standardized product (Boysen et al., 2009).
2.2 RAW MATERIALS
Raw materials are materials or substances used in the primary production or manufacturing of
goods. Raw materials are commodities that are bought and sold on commodities exchange
worldwide. Traders buy and sell raw materials in what is called factor market because raw
materials are factors of production as are labor and capital. They are used in multitudes of
products and can take many different forms. The kind of raw materials inventory a company will
depend on the type of manufacturing they do. For manufacturing companies, raw materials
inventory requires detailed budgeting and a special framework for accounting on the balance
sheet and income statement.

2.2.1 Accounting Basis

Manufacturing companies take special steps to account for raw materials inventory. This
includes three distinct inventory classifications on their balance sheet compared to just one for
non-manufacturers. The current assets portion of the balance sheet for manufacturing companies
will include:

i. Raw materials inventory

ii. Work-in-process
iii. Finished goods

All inventories, including raw materials inventory, should be valued at its comprehensive cost.
This means its value includes shipping, storage, and preparation. The typical journal entries in an
accrual accounting system for the initial purchases of raw materials inventory include a credit to
cash and a debit to inventory. Debiting inventory increases current assets and crediting cash will
reduce cash assets by the inventory amount.

When a company uses raw materials inventory in production, it transfers them from the raw
materials inventory to the work-in-process inventory. When a company completes its work-in-
process items, it adds the finished items to the finished goods inventory, making them ready for
sale.

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2.2.2 Direct and Indirect Raw Materials
In some cases, raw materials may be divided into two categories: direct and indirect. Whether a
raw material is direct or indirect will influence where it is reported on the balance sheet and how
it is expensed on the income statement.

Direct Raw Materials

Direct raw materials are materials that companies directly use in the manufacturing of a finished
product, such as wood for a chair. Indirect raw materials are not part of the final product but
are instead used comprehensively in the production process.

Indirect Raw Materials

Indirect raw materials will be recorded as long-term assets. Within long-term assets, they can fall
under several different categories including selling, general, and administrative or property,
plant, and equipment. Long-term assets usually follow some depreciation schedule which allows
the assets to be expensed over time and matched with revenue they help to produce. For indirect
raw materials, depreciation timing will usually be shorter than other long-term assets like a
building expensed over several years.

Direct raw materials are placed in current assets as discussed above. Direct raw materials are
expensed on the income statement within cost of goods sold. Manufacturing companies must
also take added steps over non-manufacturing companies to create more detailed expense
reporting on costs of goods sold. Direct raw materials are typically considered variable
costs since the amount used depends on the quantities being produced.

Direct Raw Materials Budget

A manufacturer calculates the amount of direct raw materials it needs for specific periods to
ensure there are no shortages. By closely tracking the amount of direct raw materials bought and
used, an entity can reduce unnecessary inventory stock, potentially lower ordering costs, and
reduce the risk of material obsolescence.

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Raw materials may degrade in storage or become unusable in a product for various reasons. In
this case, the company declares them obsolete. If this occurs, the company expenses the
inventory as a debit to write-offs and credits the obsolete inventory to decrease assets.

2.3 Bill of Materials (BOM)

A bill of materials (BOM) is an extensive list of raw materials, components, and instructions
required to construct, manufacture, or repair a product or service. A bill of materials usually
appears in a hierarchical format, with the highest level displaying the finished product and the
bottom level showing individual components and materials. A bill of materials (BOM) is a
centralized source of information used to manufacture a product. It is a list of the items needed to
create a product as well as the instructions on how to assemble that product. Manufacturers that
build products start the assembly process by creating a BOM.

Creating an accurate bill of materials (BOM) is vital because it ensures that parts are available
when needed as well as ensuring that the assembly process is as efficient as possible. If the BOM
is not accurate, it can cause production to halt, which increases operating costs, as time is needed
to locate missing parts, start another production order, or until the correct process of assembly is
determined.

2.3.1 Bill of Materials (BOM) Displays

A BOM displays its information in one of two ways: an explosion display or an implosion
display. A bill of materials (BOM) explosion displays an assembly at the highest level broken
down into its individual components and parts at the lowest level, while a BOM implosion
displays the linkage of individual parts at the lower level to an assembly at the higher level.

For example, a computer is exploded into hard drives, computer chips, random access memory
panels, and processors. Each processor is exploded into an arithmetic unit, a control unit, and a
register. The requirements for the arithmetic unit, control unit, and register are imploded into the
requirements for the processor, which are imploded into the requirements for the entire
computer.

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2.3.2 Types of Bill of Materials (BOMs)

A BOM list is necessary when building a product and ordering replacement parts, and reduces
possible issues if product repairs are required. It helps to plan for acquisition orders and reduces
the possibility of errors. The two main types of BOMs are engineering BOMs and manufacturing
BOMs.

Engineering Bill of Materials

An engineering bill of materials defines the design of the finished product. It includes all
alternative and substitute part numbers and parts contained in the drawing notes. Every line of
the bill of materials (BOM) includes the product code, part name, part number, part revision,
description, quantities, and units of measure, size, length, weight, and specifications or features
of the product.

The engineering BOM is often organized by engineers based on a computer-aided design (CAD)
drawing. For a finished product, there may be more than one engineering BOM created. This is a
part of product lifecycle management.

Manufacturing Bill of Materials

A manufacturing bill of materials (BOM) comprises all the assemblies and parts required to
construct a finished item ready to be shipped. It also incorporates the packaging materials
required to send the product to the customer. It contains processes that require execution on the
product prior to completion and stores all the information required for manufacturing activities.

2.4 MATERIAL REQUIREMENT PLANNING (MRP)

Material requirements planning (MRP) is a computer based inventory management system

designed to improve productivity for businesses. Companies use material requirements planning
system to estimate quantities of raw materials and schedule their deliveries.

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MRP works backward from a production plan for finished goods, which is converted into a list
of requirements for the subassemblies, component parts, and raw materials that are needed to
produce the final product within the established schedule. By parsing raw data like bills of lading
and shelf life of stored materials this technology provides meaningful information to managers
about their need for labor and supplies, which can help companies improve their production
efficiency.

2.4.1 MRP IN MANUFACTURING

A critical input for material requirements planning is a bill of materials (BOM) an extensive list
of raw materials, components, and assemblies required to construct, manufacture or repair a
product or service. BOM specifies the relationship between the end product (independent
demand) and the components (dependent demand). Independent demand originates outside the
plant or production system, and dependent demand refers to components.

Companies need to manage the types and quantities of materials they purchase strategically; plan
which products to manufacture and in what quantities; and ensure that they are able to meet
current and future customer demand all at the lowest possible cost. MRP helps companies helps
companies maintain low inventory levels. Making a bad decision in any area of the production
cycle will cause the company to lose money. By maintaining appropriate levels of inventory,
manufacturers can better align their production with rising and falling demand.

Types of Data Considered by MRP

i. Name of the final product that's being created. This is sometimes called independent
demand or Level "0" on BOM.
ii. What and when info. How much quantity is required to meet demand? When is it
needed?
iii. The shelf life of stored materials.
iv. Inventory status records. Records of net materials available for use that are already in
stock (on hand) and materials on order from suppliers.

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 v. Bills of materials. Details of the materials, components, and sub-assemblies required to
make each product.
vi. Planning data. This includes all the restraints and directions to produce such items
as routing, labor and machine standards, quality and testing standards, lot sizing
techniques, and other inputs.

2.5 MATERIAL PROCUREMENT

Procurement is a term describing the purchasing process for goods and services. In building
construction, material procurement is the process by which the materials required to construct a
building are selected, ordered, invoiced, paid for and delivered to the site .
In the private sector, procurement is viewed as a strategic function working to improve the
organization’s profitability. Procurement is seen as helping to streamline processes, reduce
raw material prices and costs, and identifying better sources of supply.

Effective and efficient procurement require good integrations in each procedure, from making
tight cost control to emphasis innovation process by applying a variety of appropriate strategies.
The main purpose of procurement practices is to coordinate and integrate every step to fulfill a
need for goods and services in a right time with a minimum processing expense, so efficient
procurement can be achieved. Hence, it is necessary to understand procurement procedures so
that firms can determine suitable strategies to apply. Moreover, partner selection, contract
formalization, payment, subcontractor selection, collaborative tools, and performance evaluation
have been initiated in a previous research as a control of the project (D.J. Bowersox et al., 2007).

Materials procurement and management is an integral part of the building process. Materials
affect every aspect of a construction project. However, smaller companies have little or no
material procurement and management systems. As a result these companies incur additional but
avoidable costs. Some of these costs are due to large delivery times for materials, excess
ordering of material, paying premium price for materials, lack of tracking of materials, lack of
communication with material providers.

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Procurement is one of the key functional areas in an organization. It is a major cost center
through which all materials are been channeled into the company. It is the organizational center
that handles the buying of all materials, exchange of materials with financial resources for
further processing. This process generates additional revenue to the company without
compromising the values and integrity of the company before its customers. Procurement
process has several definitions which are based on the act of buying goods and services and its
preparation and processing based on demand. (Turner, 2011) described procurement as a system
or process that supports organization’s total needs for the supply of goods, services and
processes that is required to achieve the goals and task established by the organization.

Procurement is also defined as the process of getting the goods and services a company needs to
fulfill its model through various tasks such as quality standards development, financing, price
negotiation, purchasing, value analysis, supplier research and selection, inventory control and
disposal of waste products like material packages (Kolenko & Kolenko, 2014.)

Also, procurement is the act of finding, acquiring and buying of the appropriate goods, services
or work from external source at the best possible cost to meet the need of the acquirer in terms of
quality and quantity, time and location (Weele, 2010). Chartered institute of procurement and
supply (2013) also described procurement as the business management function that ensures
identification, sourcing access and management of the external resources that an organization
needs to fulfill its strategic objectives

2.5.1 MATERIAL SPECIFICATION AND SUBMITTALS

Material specification is a description of materials that are agreed to be used in a construction
project by the architect/engineer and owners. In most cases construction materials are specified
from materials catalogues and past practices. Problem with this procedure is the materials
specified may not be readily available.

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A material submitted is the contractor’s proposal to approving authority a list of materials to be
used in the project. A material submittal confirms that the contractor is using materials specified
or approved equals. Approved equals are materials that are considered functionally and quality
wise equivalent to the materials specified.

2.5.2 MATERIAL ORDERING PROCESS

Materials quoting or obtaining prices for materials start with the bidding process for a job. Most
contractors acquire one to three price quotes for materials. Sometimes contractors use their own
database for prices. Once the contractor is awarded the job, the contractor provides the architect /
engineer with the material submittal. The majority of the contractors surveyed obtained three to
six estimates on materials. Ordering was done via telephone or facsimile. In-person ordering was
performed some of the times. The main reason for picking a material supplier was prompt
delivery and best price(s).

2.5.3 INVENTORY MANAGEMENT

Modeling of inventory management in construction operations which involves on-site fabrication
of raw materials was made by (Do Young Jung, 2007). The research was done to decide an
optimal level of material inventories on considering vibrant variations of resources under
uncertainty is very critical for the economical efficiency of construction projects. This paper
developed a probabilistic optimal inventory management model on the process of on-site
fabrication of raw materials such as iron-rebar process. From the research it was concluded that,
the amount of inflow and outflow iron-bars at the temporary shop attained a stability by applying
the pull system to the phase of raw material inventory management, moreover average inventory
quantity were reduced, and by eliciting optimal time lags linking to the start of fabrication /
assembly works, it was likely to reduce the holding time of assembled products, and inventory
management costs could be reduced around a total of 25%.

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For improving on-site materials tracking for inventory management in construction projects,
(Narimah Kasim, 2012) made a research. The improper handling and storage of materials in
construction site was difficult to track and locate materials. The on-site materials tracking and
locating were made complicated by using traditional tracking process which is labor intensive,
error-prone, unreliable and add to the raise in construction costs. Failure in organizing site
inventory will result in cost overrun and reduce overall project performance. He concluded that,
RFID in materials tracking helped in inventory control and retards the increase of project cost.

(Olusakin & Akindipe, 2014) made an experiment to bring to the front the prominent issue of
inefficiency in the performing inventory management and its effects on production operations of
manufacturing concerns. Data were collected by questionnaire and further analysis was done by
Pearson correlation coefficient. The study concluded that efficient management of stock would
be achieved by determination of stock levels, commitment of skilled store personnel, and the use
of automated stock control. It added that lack of stock, the resultant low capacity utilization, and
loss in production time, which improves overall efficiency of the manufacturing SMEs and breed
high performing entrepreneurs would be solved by optimal use of resources through efficiency in
the management of stock.

2.6 RELATED WORKS

Firms in the process industries utilize production processes that manipulate material properties to
produce upgraded raw materials for subsequent use in variety of application areas upstream in a
supply chain (Barnett & Clark, 1996). Process firms thus use raw materials to manufacture non-
assembled products by means of a production process where these raw materials are processed
and transformed in a continuous flow and or in batches (Blanco et al., 2013). Examples of such
industries include petrochemicals and chemicals, food and beverage, mining and metal, mineral
and material, generic pharmaceuticals, forest and steel.

Process industries constitute a substantial part of all manufacturing industry and about 25% of
the most research and development (R&D) intensive firms in the world belong to this cluster of
industries (Lager, 2010). Often referred to as commodities and sold in factor markets, raw
materials are the basic materials from which products are manufactured or made (Oxford English

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Dictionary). Clearly, input material put heavy constraints on output products. Given the
importance of raw materials as the critical input, and the increasing challenges related to raw
materials supply, a systematic and effective approach to the management of raw materials is
critical to any firm in the process industries.

The way companies deal with the raw material challenges affect both short-term operations as
well as long-term business opportunities. For instance, from a short-term perspective, when
supply of raw materials is smooth, operations may progress favorably but when it is interrupted,
the impact on businesses is often immediate and severe. From a long-term perspective, changes
initiated by the company or forced upon them by others could have both constraining and
retaining effects on the value proposition(s) of the company.

An example of the constraining effect on value propositions is changes of raw material quality
that the process firms deliver to the market. Within the metal powder industry, changes in scrap
metal quality (with higher degrees of alloying elements) put constraints on powder producers’
ability to sustain their value proposition. The volatile political and regulatory environment for
raw materials has made raw material management more acute in corporation governance.
Policies and regulations do not only affect the availability of raw materials, e.g. Dodd-Frank Bill
affected the supply of cobalt from Congo, which at that time was one of the largest exporters of
cobalt. Environmental regulations and trade barriers delimit the options of supply and increase
the cost of global sourcing. Regulations also dictate what handling processes and waste treatment
to be used for different kinds of materials.

Final products have to comply with the standards set by regulatory authorities. From the
perspective of the firm, raw materials management is thus a complex task because raw materials
clearly affect many parts of any firm. Therefore, there is a need for some level of coordination of
activities and processes that firms use to handle and manage its raw materials.

Raw materials management is the activities that go into e.g. acquiring, purchasing, refining,
developing and delivering a sufficient amount of raw materials at a sufficient quality to ensure
that the strategic and operational objectives of the firm is achieved. Raw materials management
thus implies exchanges with the external environment, as well as firm-internal material

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conversion issues. Effective raw materials management means performing all these activities
proficiently, i.e. faster, with higher quality, lower risk, and with fewer inputs and defects.

At present, however, even if bits and pieces of knowledge about this topic is available, extant
research does not allow for qualified advice about how companies can create and sustain
proficient principles and methods for raw materials management. This article heads at providing
such knowledge by drawing on the experiences of the Höganäs Corporation, the world leader in
powder metallurgy, in creating principles for proficient raw materials management.

(Olusakin & Akindipe, 2014) made a study on role of raw materials management in production
operations. The author was conscious about the inefficiency in raw material management and the
alternate solutions to overcome the problem. He found the relationship between raw material and
Inventory management to solve the crisis. From this he had concluded that, the inefficiency were
due to illiterate and non experts involvement in management, mishandling of materials and
inability to use proper inventory model in the site. He added that, all the above said reasons are
mainly due to the managers involved in the management process.

(Boopathi, 2016) has made a study on material management using a real time residential project.
The author had an opinion that the cost of the project increases mainly due to the improper
material management. So in this project, planning, scheduling and budgeting were done by
PRIMAVERA. Since he had followed a proper scheduling method there was no increase in cost
of the project. The material cost constitutes the 50% of total cost which is normal.

An empirical case study of material management in Residential project was done by (Anup
Wilfred, 2015). This study was made to find out the problems occurring due to the improper
material management. Due to these problems, there will be rise in cost of the project. So he had
undergone ABC analysis and S curve analysis. ABC analysis give complete study of quantity of
material utilized. The S curve analysis was helpful in finding the deviations in project. Class A
materials give the profit rate. The deviation from scheduled project is found by S curve analysis
and suitable measures were taken.

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